The Day the Rare Earth Bubble Will Pop

Predicting a bubble is a fool's errand, but as a writer for The Motley Fool I might as well put my Fool hat on and take a shot.

If I remember my economics correctly, the laws of supply and demand eventually balance themselves out in the real world. Prices go up when demand outstrips supply, and prices go down when supply meets back up with demand. That's exactly how I am going to predict the day (plus or minus a few months) the rare earth bubble will pop.

Let me be very clear, I don't think Molycorp (NYSE: MCP  ) Rare Element Resources (AMEX: REE  ) or China Shen Zhou Mining & Resources (AMEX: SHZ  ) will be falling off a cliff any time soon. For now, rare earth elements are in a state of very high demand and supply is tight with China's export restrictions. Combine that with the inelasticity (meaning buyers will pay whatever price it takes) of rare elements, and prices have gone through the roof in recent months.

The problem for rare earths going forward is a glut of supply coming into the market. These rare earth elements aren't really rare, so anyone with a possible mine is building mining capacity or at least drilling to see what they've got. One of those mines can make a big dent in world supply, and the world has a half-dozen or more in the works.

As it stands right now, there is demand for 130,000 metric tons of rare elements annually, and China, with lower export quotas, is exporting 30,000 metric tons a year. Molycorp estimates there are 50,000 metric tons of demand outside of China right now, so supply is 20,000 metric tons below demand, causing high prices. But supply will be increasing as capacity comes online in the next few years.

Company

Expected Launch

Capacity (metric tons)

Lynas Q3 2011 22,000
Molycorp ~Q3 2012 20,000 (up to 40,000)
Arafura Resources 2013 20,000
Avalon Rare Metals (AMEX: AVL  ) 2015 10,000

Assuming China doesn't cut off exports altogether (a possibility at this point) and exports stay around 30,000 metric tons annually, Lynas will be able to pick up all of the slack in 2011. If supply and demand are aligned around 50,000 metric tons annually by the start of 2012, where will that leave us? Molycorp, which will likely increase capacity to 40,000 metric tons (if my crystal ball reads correctly), comes online in 2012 and the two companies can supply the world's needs (outside of China). Even if you think demand will go to 70,000 metric tons by 2012, there should be plenty of supply.

Then comes Arafura, Avalon, Rare Element Resources, Quest Rare Minerals, the list goes on and on. Even if we reach 210,000 metric tons of demand by 2015, the new mines should be able to pick up the slack, leaving supply and demand more in line.

I also haven't considered rare earths being designed out of some products, a half-dozen other mines in the works, new recycling technology, or the possibility the World Trade Organization rules China can't restrict supply to the rest of the world.

A big word of caution
The first big drop could come on Jan. 25 when Molycorp insiders can start selling their own stock. Last year, Tesla Motors and A123 Systems both saw price drops on the day their lockup period ended. Molycorp will likely see the same.

Predicting the fall
Molycorp will take its first nosedive on Jan. 25, but the big fall will start later in the year when people realize there won't be a shortage for long. If you're looking for an exact date, I'll throw a dart at the calendar and get ... Oct. 12, 2011.

What to do now
If you have the gumption to stay in the rare earth trade until the bitter end, you have more guts than I do. For a lightweight way to play rare earths, there is the Market Vectors Rare Earth/Strategic Metals ETF (NYSE: REMX  ) . The ETF invests in other metals benefiting from high-tech manufacturing like Motley Fool Stock Advisor pick Titanium Metals (NYSE: TIE  ) and Thompson Creek Metals (NYSE: TC  ) . Neither are really rare earth plays, but they both have solid revenues, unlike rare earths, and will benefit from the same high-tech movement driving rare earth prices higher.

Interested in reading more about Molycorp? Click here to add it to My Watchlist to find all of our Foolish analysis on this stock.

More on rare earths:

Fool contributor Travis Hoium does not have a position in any company mentioned. You can follow Travis on Twitter at @FlushDrawFool, check out his personal stock holdings or follow his CAPS picks at TMFFlushDraw.

Titanium Metals is a Motley Fool Stock Advisor pick. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (18) | Recommend This Article (24)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 06, 2011, at 7:46 PM, HolgarDanske wrote:

    Subtitle to the Article - And that Day is Today

  • Report this Comment On January 06, 2011, at 7:55 PM, skunkaroo wrote:

    Looks like you're a little late with your prediction on Molycorp. It popped today (1/6/2011 -13%) :)

  • Report this Comment On January 06, 2011, at 8:52 PM, optionpop wrote:

    So what caused it? Same thing happened to REE. What's going to happen tomorrow?

  • Report this Comment On January 06, 2011, at 11:25 PM, CAFFPM wrote:

    @optionpop: Several issues.

    Headline risk is getting to be old news

    Short squeeze (there was a 8%+ short interest) that's come to an end

    almost 100% gain in a month demands some profit taking

    rumor of a secondary

    Valuation isn't justified by addressable markets, takeout price or underlying commodity price.

  • Report this Comment On January 07, 2011, at 12:22 AM, optionpop wrote:

    @CAFFPM:

    Weren't all those things true yesterday and the day before? Was there some news today that triggered it?

  • Report this Comment On January 07, 2011, at 1:20 AM, garethhatch wrote:

    China Shen Zhou Mining & Resources is not a rare-earth company.

  • Report this Comment On January 07, 2011, at 1:20 AM, REEexpert wrote:

    I never read an article that was more offbase and innacurate off any news source in my life....

    I have owned Moly corp since it was $24, and bought and sold it 5 times with my highest print at 55.60 (when CNBC started talking about it, then its always time to get out)

    First the demand is 120k a year going up to 200k by next year.

    As far as China is concered, 2 weeks ago they said they were going to be raising thier quotes, then last week they cut by 11%

    Bottom line is that China's own demand will out pace production by 2012. They owe the world nothing and driving the economic growth of the world. They economic policy is "China first, everyone else, tough"

    Second mistake is Demand, You gave output projections as current projects. Moly mines 3k, going up to 20k and hopefully in 3 years will be at 40k.. Lynas does a fraction and Avalon isnt online for years...I dont know where you learned math but if we go up 210,000 in demand, where is the supply coming from?

    The best part is you have done so little research on REE that you think it can be pulled out of the groud and used, the minerals have to be refined. Moly is the only publically traded company that can refine these into a usable product, besides one other company in the USA and they are private. How bought the 8 year barrier to entry in to the market?

    If they werent rare and so easy to sell why wouldnt TC and TIE start selling them, they dont want to be involved in a commodity up 600% in price in the last 6 months...of course they do, heres the catch buddy..REE are Rare because they arent found in large concentrations in one area execpt China, Canada, Molly mine in Cali, and Canda.

    You are embarassment, dont you have to read something before writing this article..google "HR 6160" and learn the difference btwn a heavy and light rare earth element....sad

  • Report this Comment On January 07, 2011, at 9:33 AM, yemoko wrote:

    I would like to clarify with you that SHZ is not really a rare earth's company.

    I have spoken to various experts in the area. My findings are summarized below.

    SHZ mainly produces fluorite (also called fluorspar) which is not a HREO (heavy rare earths oxides). (The principal applications of fluorite are: (i) flux in steel/aluminum, (ii) opalescent glass, enamels and cooking utensils, (iii) hydrofluoric acid. Here’s the Wikipedia link on it: http://en.wikipedia.org/wiki/Fluorite.)

    Someone on Seeking Alpha posted his/her assumption that a fluorite mine – in Mozambique! – had a "discovery" of REE that can possibly be replicated at SHZ's mine in China. This is a faulty assumption and is not relevant to SHZ.

    Even if one does assume that the Mozambique mine possessed "real" HREO (heavy rare earths oxides), the test results are anything but good: 0.44% HREO content with a heavy mix of 50% (so, 0.44% x 50% = 0.22% in situ grade of HREO, and it isn’t clear whether these are “real” HREO or they include zirconium or other low-value quasi-heavy materials).

    Rare earths elements are found anywhere and everywhere. It is outlandish to assume that fluorspar deposits characteristically contain HREO. It is even more outlandish to assume that the HREO deposits are economic.

    Hopefully this can help clarify some widespread misperceptions about SHZ.

  • Report this Comment On January 07, 2011, at 9:53 AM, cdantoin wrote:

    Molycorp's HREE counterpart: Alaska's Bokan Mt. former operating mine, UCORE (Jack Lifton)

    Company: UCORE

    Vancouver Exchange: UCU.V

    NYSE: UURAF.PK

    Industrial College of the Armed Forces, http://www.ndu.edu/icaf/programs/academic/industry/reports/2...

    State of Alaska House of Representatives: House Resolution #16 http://treo.typepad.com/raremetalblog/2010/04/news-state-of-...

    DOE_CriticalMaterialsStrategy

    http://www.energy.gov/news/documents/criticalmaterialsstrate...

    News:H.R. 6160, the Rare Earths and Critical Materials Revitalization Act of 2010 (“the Act”), by the U.S. House of Representatives: “While these Acts together promise to give U.S.-based rare earth producers a remarkable edge in the race to replace specialty metals now dominated by China, very few domestic projects have the qualifications of Bokan as a strategic military and technological asset,” said Jack Lifton, a leading REE expert and a party to the initial drafting of proposed RESTART legislation. “As the largest historically documented Heavy rare earth deposit in the U.S., Bokan is a counterpoint to Molycorp’s primarily Light rare earth deposit at Mountain Pass in California. Together, these two deposits, located in relative proximity to each other and on U.S. soil, have the potential of liberating the U.S. from non domestic rare earth dependencies in the near term.”

    Ucore Investor Presentation Aug 2010.ppt

    http://treo.typepad.com/UCU%20Inst%20Presentation%20%20Aug%2...

    Chris DoD employee

  • Report this Comment On January 07, 2011, at 10:02 AM, 900gc wrote:

    Share prices will fall going into the lockup exp. as people bail out before the big drop. Anybody that got in early has made a ton of $$ already so why risk losing more?

  • Report this Comment On January 07, 2011, at 11:29 AM, cattywampus wrote:

    Wow! up until now I thought interest in this stock was as rare as promethium.

  • Report this Comment On January 07, 2011, at 3:20 PM, teconom wrote:

    Hey REE'expert'....u may need to pull out your history books and reread the chapter on what China did last time we were in this situation...

    When Moly and REE and all these other companies finally come online...which will take years...China will flood the market with not-so-rare-earth minerals and drive down the price...which will put all the players out of business...Again!!

    And MCP and REE go to sub $1 stocks where they should be.

    However, sounds like u have made some nice momentum trades in the mean time. Take ur sack of money and move on to something else. Maybe Uranium...

  • Report this Comment On January 08, 2011, at 1:39 AM, studtrader wrote:

    Motely fool. is all ways wrong they try to get investors to sell so they can buy shares

    or let there friends buy.

    they are idiots from the word go.

    Never listen to them

    they are trouble.

    they will say anything

    to get a stock down

    or pump one up acoding

    wo what side they want to

    be on.

  • Report this Comment On January 10, 2011, at 3:55 AM, renderus wrote:

    What is China’s 5 Year Plan to stop China Rare Earth exports to foreign countries/companies?

    Are we already in Year 2?

    What year does the Chinese Rare Earth spigot close tightly: 2013? 2014?

    Why does China sell any foreigner any raw rare earth at “cabbage prices”?

    Why doesn’t China use all of their rare earth metals to manufacture high tech rare earth products such as wind turbines, hybrid cars, smart bombs and sell them at a much higher price?

    Why does the “developed” countries/companies look at the glass 35 percent empty, when the glass is currently 65 percent full.

    Isn’t China methodically allowing the rest of the world to prepare for the new reality? Find your own rare earths; We (China) intend to use all of our own?

    What are the large developed countries/companies willing to pay for secure rare earth resources?

    “Whatever it takes” comes to mind.

    What will Lynas and Molycorp receive for their rare earths next year? Cabbage prices or premium prices?

    Tiny Australian and Canadian companies with the heavies: Northern Uranium, Arafura, Alkane, Greenland, Great Western, Avalon, U-Core. How tiny will their market caps be in 24 months?

  • Report this Comment On January 10, 2011, at 8:27 PM, vanvita wrote:

    I am afraid you have not done your homework.

    Arafura, despite what they say, are unlikely to be in production until well beyond 2015.

    Thye say they have "solved" their technology problem.

    By this they mean they have made some simple bench tests.

    They have allocated in excess of 25 million dollars to "technology" - i.e. mineralogy from their recent capital raising. If the mineralogy was solved why this huge allocation to it? There is,in fact, no guarantee that this company (like many other rare earth hopefuls) will in fact be able to solve their mineralogy in a way that twill make their projects viable. There is huge technical risk in many of these companies that the market either does not understand or is ignoring.

    I emailed Arafura and challenged them on some of their assertions and received no reply.

    Molycorp, Lynas and Alkane Resources are the real deals in this space at present, and of these three Alkane, dollar for dollar is by far the best buy.

    Most of the others are yet to prove either technology or business model viablity.

    Supply will be limited well beyond 2015 -2018, China will continue to tighten as rest of world supply comes online to ensure that they keep getting high FOB prices and supply demand will balance out by 2020 - no new mine will open to "flood" the market if supply demand is leveling out.

    For the companies that are the real deal it is going to be a bonanza. The others won't get a start.

    My guess is that there will probably be 4-6 non-Chinese mines and they will be very very profitable long term investments.

  • Report this Comment On March 28, 2011, at 3:07 AM, daddysretirement wrote:

    All of what most of the posts make sense in one way or another. Investors keep ignoring the National Security implications.

    Do any one of you think that a mineral that is fundamental to the manufacture of guided missiles is something we will readlly farm out to a hostile country?

    Molycorp is the main player, and she will not be allowed to fail. You got it? Or have I got to slap you over the head to help you figure out how national security meets manufacturing?

    Do I have to? Get your act together.

  • Report this Comment On March 28, 2011, at 4:05 AM, ryanalexanderson wrote:

    > Or have I got to slap you over the head to help you figure out how national security meets manufacturing?

    Wow, that's a lot of anger directed towards a thread that's been silent for 2.5 months.

  • Report this Comment On May 07, 2011, at 11:51 AM, OldenAtwoody wrote:

    "The Day the Rare Earth Bubble Will Pop"

    When? The day you can pick an iPhone off a tomatoe plant in your front yard, as in - never.

    Expect a strategic reserve program from Congress focused on buying domestic ore.

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